Expiring Opportunity to Make Large Gifts: Time is running out on the ability to give away US$5.12 million (US$10.24 million for married couples) without paying Federal gift tax. The extension of the "Bush Tax Cuts" that President Obama signed into law in December of 2010 contained a provision that increased the estate, gift and generation-skipping transfer ("GST") tax exemptions to US$5 million in 2011 and US$5.12 million in 2012. These exemptions are currently scheduled to expire at the end of this year. Unless Congress acts to change the law, the gift and estate tax exemptions will go down to US$1 million and the GST tax exemption will go down to US$1.34 million on January 1, 2013. The maximum gift, estate and GST tax rate is scheduled to increase from 35 to 55 percent on that date. In short, there is a high degree of risk that large gifts (more than US$1 million or US$2 million for a married couple) will cost significantly more if made after December 31, 2012.* One should therefore consider "locking-in" the current exemptions with a gift this year.
When considering whether to take advantage of the current exemptions, one should remember that a properly structured transfer can protect from estate and gift tax not only the transferred property, but also all income and appreciation on the property after the gift is made. Taxes can be reduced even further through the creative use of trusts that permit assets to pass through multiple generations without further transfer taxation. Trusts can also protect the assets from claims of a beneficiary's creditors and provide other benefits.
If you wish to make use of the current gift tax exemption, particularly if you plan to use a trust structure for the gift, it is imperative that you begin the process immediately. It will take time to draft the appropriate documents and take the steps required to complete the transfer before the year-end deadline.
Some states impose a gift tax and have an exemption that is lower than the current Federal exemption. Depending on where you live, a large gift may generate a state gift tax even though it does not create a Federal gift tax (e.g., Connecticut has a state gift tax; New York does not).
When property is transferred by a lifetime gift, the donee receives the donor's income tax basis in the gifted property. On the other hand, property that is transferred at death receives a basis "step up" to the fair market value of the property at that time. This means that low-basis property transferred by gift may generate a higher capital gains tax when sold than if the property had been retained and sold after death. One should therefore carefully assess the overall tax costs and benefits of any gift, particularly if appreciated property is involved.
* We cannot predict what exemptions and rates will ultimately apply next year or beyond. President Obama's last budget proposal called for US$3.5 million estate tax and GST tax exemptions, a US$1 million gift tax exemption and a 45 percent top rate. It is also possible that gifts of the current exemption amount made this year could be "clawed-back" in a way that wipes out the benefit of the gift if the exemption amount is lower at the time of the donor's death.
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© 2012 White & Case LLP
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